Decapentaplegic (dpp), a TGF beta-related ligand, plays a key role in Drosophila development. Although dpp receptors have been isolated, the downstream components of the signaling pathway remain to be identified. We have cloned the schnurri (shn) gene and show that it encodes a putative zinc finger transcription factor homologous to the human major histocompatibility complex-binding proteins 1 and 2. Mutations in shn affect multiple events that require dpp signaling as well as the transcription of dpp-responsive genes. Genetic interactions and the strikingly similar phenotypes of mutations in shn and the dpp receptors encoded by thick veins and punt suggest that shn plays a downstream role in dpp signaling.